Category Archives: Economics

Should You Manufacture That Product?

A recent article over on Industry Week that asked you to “show me the money” laid out six money questions that the author believes should be asked and answered before a manufacturing decision is made because a product that can’t be manufactured affordably shouldn’t be manufactured at all. As a supply chain professional, it’s your job to ask, and answer, these questions even if product development doesn’t, and even if the product can’t be cut, your job to figure out if it’s cheaper to build in house or outsource.

So, what are the key questions that should be answered?

  • How much will the total project cost?
  • How many products will be sold in a year? and
  • How many years will it take to get your investment back if you manufacture in house?

If the ROI will take years because an investment in new technology is needed, then, even if outsourcing adds cost, it might be the right idea.

For more insights, including the questions to asks (and calculations to do) if you’re trying to decide whether or not to manufacture a product in the first place, see the article.

Procurement Is Worth IT

So listen to the CPO Agenda when it says that Procurement Professionals should get bonuses, even though it might make this recommendation for the wrong reasons.

If Sales gets bonuses for making a sale, which brings the organization X cents to the bottom line for every dollar sold, then Procurement, which brings the organization 5X to 20X cents to the bottom line for every X dollars saved should definitely be in line for a bonus.

Plus, as the CPO Agenda suggests, if fixed costs are still a problem from a (short-sighted) organizational viewpoint, performance-based bonuses should be much less of a problem, especially if they are based on cost avoidance or savings, as a CFO can’t argue with numbers that improve the bottom-line 10X as much as the same numbers from Sales improve the bottom line.

Plus, if you want to retain talent, this is the best way to do it. Just like a hedge fund manager jumps to the investment house that will give him the biggest reward, your stars are going to jump to the organizations which give them the biggest rewards. And as much as you’d like to think that work-life balance, empowerment, and sustainability are important to your team, in general, nothing compares to a bigger paycheck which gives your star the ability to control their own work-life balance, a feeling of empowerment, and the ability to financially support their own sustainability goals.

So give your stars performance-based bonuses. They’re worth it.

Productivity Truths

The McKinsey Quarterly recently ran a great article on “five misconceptions about productivity” (registration required) that is a must read for anyone thinking about not greenlighting an investment in new supply chain technology. As per the article:

  • Productivity IS a priority
    In order for the US to sustain its average historical GDP growth of 3.3% with the projected declines in labor-force growth, productivity growth needs to increase at an annual rate of 2.3% — a rate of growth not achieved since the 1960s. And since the supply chain is the dominant driver of productivity in most organizations, supply chain needs every productivity increase it can get.
  • Productivity IS a job saver
    With a continuing lack of credit and a slow sales rebound in most sectors, your average company can not afford to hire and still has a significant need to do more with less as it first has to grow with the resources it has. Productivity increases help a company keep costs under control, which reduces the chances it will need to layoff.
  • Productivity gains ALSO come from increasing value
    If a new technology will allow the company to identify value or increase value, it’s a must. For example, an analytics system that will help pinpoint key value addes across a product line, new sustainable warehouse technologies (such as hybrid vehicles), or investments in new technologies that reduce plant energy requirements, can increase profit, brand image, and/or sales.
  • Productivity IS AS important to leaders as losers
    How do you think leaders stay leaders? They continue to make gains year after year!
  • There is NO LIMIT to Productivity Gains
    McKinsey’s research estimates that three quarters of the productivity gains required by the US can be achieved simply by applying best practices across the private sector! Imagine what new technology and methodologies could do!

Transfer Pricing – Do You Know What You Need To?

Transfer pricing, which allocates profits and losses among different parts of a multinational entity for tax and related purposes, can have a significant financial effect on your supply chain because the companies in a commonly controlled supply chain must comply with transfer pricing rules and regulations in determining what companies should recognize what amounts of income, deductions, credits, and allowances among the various tax jurisdictions.

Transfer pricing regulations, which are governed under section 482 of the tax code that authorizes the IRS to adjust the income, deductions, credits, or allowances of commonly controlled taxpayers to prevent evasion of taxes in the US, and which must follow OECD Transfer Pricing Guidelines, can be quite complex, but as this recent article in Industry Week on “what manufacturers need to know about transfer pricing”, most regulations are based on one underlying principle: the arm’s length principle.

The arm’s length principle is the condition or the fact that the parties to a transaction are independent and on an equal footing. Transactions based on the arm’s length principle are arm’s length transactions and used in contract law to arrange equitable agreements that will stand up to legal scrutiny, even though the parties may have shared interests or are too closely related to be seen as completely independent. The principle requires that the amount charged by one party to another (related) party must be the same as it would be if the parties were not related. An arm’s length price is the same price that an independent company would pay for a good or service.

This sounds pretty easy until you get into international transactions when trying to split profits and you have to figure out who bears the product liability, the risk of currency fluctuations, and so on. At this point, most multinationals will use a transfer pricing study that performs a detailed analysis of the functions performed, assets employed, and risks borne by each party in the transaction. This will provide a justification of the cost breakdown that will stand up to regulatory and legal scrutiny.

For more information on transfer pricing, see the Transfer Pricing Network in the US, the Cole & Partners Transfer Pricing Site in Canada, or the Transfer Pricing Forum in the EU. Understanding the profit breakdowns will help you understand the cost savings that Procurement directly and indirectly generates for the supply chain.

Don’t Go Gaga Over Global Trade Numbers

Global Trade may be growing, but it’s not growing as fast as the WTO wants you to believe. You have to take the long term view. Global Trade may have increased 13.5% last year, but this followed a year where it dropped 12.2%. Just like an elastic will snap back when released, it is only logical to expect that global trade would snap back to pre-recession levels once the world, and the US in particular (which alone controls 25% of Global GDP) started to work its way out of the recession. And that’s all it did … snap back. (If it was at 100$, and it dropped by 12.2%, then it was at 87.8$. If that increased by 13.5%, the net result would be 99.65$.)

With more and more companies trying to go global and join the outsourcing economy, and with more and more hi-tech manufacturing shifting overseas, it’s only logical to expect that global trade will continue slow, steady growth whether it makes sense or not, but we’re not going to see exponential expansion anytime soon. As a result, while Global Trade Management software (GTM) sales will pick up in the US where advance filing, denied party lists, and other requirements are making GTM almost impossible without software support, GTM software is not likely to see the same sort of increase in demand in other countries. (Security regulation is also increasing in Europe, but not at the rate it is in the US, at least for the moment.)

In other words, GTM is a solid investment for buyers and vendors alike, but don’t look for rapid growth predicted by the ARC Advisory Group, in this article on realizing global trade management potential, just yet.